One can forgive investors for not knowing what to make of Amazon (NASDAQ:AMZN) stock. The conglomerate attracts attention partly because of its numerous initiatives across multiple industries. However, of course, it’s most well–known for its e-commerce operations.
Admittedly, those who focus on Amazon;s retail business will view AMZN stock as a loser. That’s largely because the company’s new initiatives in that area are cutting into its profits.
However, most of Amazon’s profits are now generated by its cloud business, Amazon Web Services (AWS). Amazon had a crucial setback in that area as well, as it recently lost a huge Pentagon contract to Microsoft (NASDAQ:MSFT).
However, given the growth of the cloud and the profits that Amazon’s cloud business should generate, investors can still profit from AMZN stock.
AMZN Is Stuck in a Holding Pattern
Recently, AMZN stock has been range-bound, partly because the company is offering costly new benefits to Prime members such as one-day shipping. Those initiatives are weighing on the company’s profits and hurting the performance of AMZN stock.
Still, for all of the focus on Amazon’s retail operations, they have never generated the majority of the company’s profits. The e-commerce business has helped the company’s revenue climb rapidly. But the business’s low margins have kept a lid on its profitability, preventing it from lifting Amazon stock price very much.
In fact, Amazon stock hasn’t risen much over the last 18 months. There are a few reasons for that.
In the past, investors have been concerned about the valuation of AMZN stock. Amazon’s retail business has also lost its air of invincibility as retailers such as Walmart (NYSE:WMT) and Target (NYSE:TGT) have successfully fought back against Amazon recently.
Focus on Profit Growth
Still, the company’s cloud business, AWS, drives the majority of its profits. So Amazon stock price should primarily be determined by its cloud business.
AWS has had some problems lately. It did not obtain a $10 billion contract to upgrade the Department of Defense’s cloud infrastructure. Microsoft got the lucrative deal instead.
Competition from other cloud providers has also worried the owners of AMZN stock. For example, Alphabet’s (NASDAQ:GOOGL, NASDAQ:GOOG) Google Cloud just made itself more of a threat to AWS by acquiring CloudSimple.
Still, I think investors are ignoring the massive amount of earnings increases that AWS will likely generate.
Analysts, on average, forecast mean annual profit growth for AMZN of 50.3% over the next five years. The anticipated rapid profit growth makes Amazon’s forward price-earnings ratio of around 62.4 acceptable. The fact that the P/E ratio of AMZN stock has often been well over 100 in past years makes its current valuation more attractive.
More importantly, Amazon;s profits are expected to increase at a rate typically achieved by successful start-ups. Yet, based on market cap, Amazon is the fourth-largest company in the world,. It’s unusual for such a large company to increase its profits so rapidly.
Amazon’s profit growth has decelerated this year. But the cloud industry, which generated revenue of $182.4 billion in 2018, is expected to grow to an estimated $331.2 billion by 2022. For all of the talk about its competition, AWS remains the leader of this segment.
As investors begin to see AWS rapidly grow, I think they will again overlook the high valuations of AMZN stock, enabling Amazon stock price to retest its highs above $2,000 per share.
The Bottom Line on AMZN Stock
After trading at triple-digit-percentage P/E ratios for a long time, AMZN stock now has a forward P/E ratio of around 62. Moreover, for all of the attention its retail business receives, Amazon primarily depends on the cloud for most of its profits.
Despite losing the Pentagon deal, Amazon is expected to generate annual earnings growth of over 50% on average after this year. As these numbers begin to show up on the company’s earnings reports, Amazon stock should jump to $2,000 per share and beyond.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.